John Dowdall
There is no doubting that Solvency II, the new Europe-wide rulebook to make sure the assets held by insurers will meet their liabilities, has already started to have an impact on how those insurance companies are investing their money.
Not surprisingly, this is an issue that has attracted significant interest across Europe’s asset management industry, given that insurers are probably asset managers’ single largest customer base, with an overall investment of around €9.9trn.
The most significant innovation in relation to asset allocation brought about by Solvency II is the tiered structure of capital charges that correspond to assets with different risk levels. OECD equities have a charge of close to 40%, whereas for high-quality sovereign bonds this can be as little as 0%. Not surprisingly, this has dampened enthusiasm among insurers for higher-risk asset classes, as the capital charge increases the hurdle the assets have to reach in terms of payback.
Many of the fund managers we have talked to are reporting a significant shift away from risk assets, a fact that will play on the minds of those in the investment industry as often those securities are ones that can attract a higher fee. Taking risks Solvency II came into force on 1 January this year and we think much of the movement during the past few months is an initial play into safety. As a result, we expect insurers to radually expand again into higher-risk categories in the months to come.
Indeed, insurers have history in this area – Axa Investment Managers estimated that €500bn was pulled from equity markets by insurers a few years back as they anticipated the new rules. However, the low-yield environment sent them quickly back into assets and securities that, while riskier, could pay a higher return.
We think that pattern will repeat itself as insurers struggle to find assets at the lowrisk end of the spectrum that can make the returns they need. Interestingly, we have already seen some spikes of investment into areas that normally would be considered fairly exotic in the insurance environment.
Infrastructure investments are attracting interest. One of the key reasons behind this is the EU’s decision to lower the Solvency II charges on these assets so as to attract more investment into the area. The EU said last year it needed up to €2trn invested in infrastructure, but that European insurers had only €22bn in the asset class – just 0.3% of their assets. Another area we hear is attracting attention is securitised bank loans.
When you introduce a set of rules as prescriptive as Solvency II, it is not surprising to get some interesting consequences in terms of the way people invest. If we were to come to a conclusion on how the system is working at this early stage, we would say the difference in capital charges between classes is too wide and therefore could encourage insurers to lurch from one extreme to the other – at one time seeking to lower capital charges but moving into higher-risk assets when they find their low-risk investments are not returning enough.
This is an area where the asset management industry should be able to give advice to the regulator. After all, not only are these rules affecting insurers, they have a direct impact on asset managers as well.
And there are other areas where asset managers can be leaders in Solvency II rather than passive bystanders. The new regulations incentivise insurers to move into certain securities and out of others. But there are two sides in every trade – with increased regulation in many areas there are forced sellers and buyers in more assets. There could be many investors out there looking for those assets that insurers want to shed, and vice versa. Investment managers are in pole position to help facilitate this.
In fact, although asset managers might rue the introduction of Solvency II as a piece of regulation aimed at another industry but with far-reaching consequences affecting them, they are benefiting in one key way. We have seen a significant improvement in engagement between asset managers and their insurance clients, driven by necessity from the new rules. That has led to an increased willingness on the part of asset managers to manufacture products and provide services that their clients require.
If Solvency II continues to encourage this trend, then fund managers and their insurance clients should at least, in part, be thankful for it.
This article was originally in Portfolio Adviser's June '16 magazine.